How Rising Interest Rates Can Impact Your Mortgage and Housing Affordability

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Now that the Federal Reserve’s Federal Open Market Committee (FOMC) has voted to raise interest rates for the first time in 2017, it is important to consider what this might mean for borrowers. Specifically, home buyers.

The first thing to consider is that there likely will be one or two more rate hikes in 2017, and more hikes are expected in 2018.

When people buy houses, there can be a degree of interest rate sensitivity attached with the purchase price and housing affordability. After all, most people have a mortgage that is larger than any other loan they have. And mortgages come with interest rates, and rising rates means they are more expensive.

24/7 Wall St. went to the mortgage calculator at Bankrate and went for a $250,000 home price with 20% down for a total mortgage of $200,000. At a 4% rate for 30 years, it came to $954.83 per month without taxes and other items. At 4.5% for a 30-year mortgage, the payment jumps to $1,013.37 per month, and at 5.0% it jumps to $1,073.64.

All in all, a 1% rise in rates on a $200,000 mortgage would add $118.81 per month to your mortgage expense, or $1,425.72 per year. That is a number that might not kill a home purchase, but it might for some buyers that were already pushing the envelope.

Perhaps the biggest risk for rates and home buyers about this week’s rate hike from Fed Chair Janet Yellen and the FOMC is that Yellen was not incorporating any major fiscal stimulus from the Trump administration into its forecasts. She told CNBC that they have penciled some gains in but were not incorporating a full spectrum of stimulative and expansionary issues. What if more rate hikes are necessary to stave off inflation?

There are other issues to consider about how rising rates will affect housing. Some are from market pundits and some are from economic views. Mortgage rates tend to track the direction of the 10-year Treasury note and the 30-year Treasury bond. While rates are low, a recent average mortgage of about 4.21% over the last week is versus about 3.7% a year ago.

The most recent housing market numbers looked incredibly strong. Due to warm weather, a strong economy and increased demand, the U.S. Department of Commerce showed on Thursday that February’s housing starts have effectively hit a 10-year high. What should be considered is that there was less conviction about the chance of a rate hike at the start of February that there was at the end of February and in the first week of March. The housing starts came in at a 1.288 million annualized rate, with a 1.213 million annualized rate for total permits. These compared to Bloomberg consensus of 1.27 million on each. Bloomberg’s economic reporting group said:

Permits for single-family homes, where building costs and sale prices are the highest, rose 3.1 percent in February to an 832,000 rate that, in good news for a thinly supplied new home market, is up 13.5 percent year-on-year. This is offset, however, by a downturn in multi-family units where permits fell 22 percent in the month to a 381,000 rate that is down a yearly 11.2 percent.

PNC’s economics team expects the FOMC to raise the federal funds rate twice more this year (in June and in December) to go up to a range of 1.25% to 1.50% at the end of the year. Their forecast is then for another three rate increases in 2018 for a range of 2.00% to 2.25% by the end of the year. PNC actually expects the fed funds rate to reach its long-run value of 2.50% in mid-2019, which is below the FOMC’s median projection for a median long-run funds rate of 3.00%.

According to Charles Schwab, the FOMC’s statement acknowledged that inflation has increased in recent quarters and was moving close to the Fed’s 2% objective but also pointed out that core inflation measures continued to run below 2%. The firm also observed that the statement said inflation likely will stabilize around 2%, and that their view is that the recent rise of some inflation above the 2% objective may be temporary. The Charles Schwab insight said:

Treasury yields dropped sharply immediately following the meeting, likely because the projected pace of hikes this year and next was unchanged. But keep in mind that Treasury yields had already risen significantly over the past few weeks in anticipation of the hike. Two-year Treasury yields had risen to their highest level since 2009, while five-year Treasuries were at their highest level since 2011. Even with the post-meeting decline, short- and intermediate-term Treasury yields remain at their highest levels in years. … We don’t think the prospect of rising short-term rates should send bond investors to the exits… keep in mind that in past cycles, bonds yields tended to peak (and prices reach their lowest point) before the Fed was finished hiking rates.

Bankrate.com also noted that mortgage rates rose this week. The benchmark 30-year fixed-rate mortgage rose this week to 4.44% from 4.38%. This was represented as the highest rate for the 30-year fixed mortgage since it was at 4.48% back in April of 2014.

It’s not just first mortgages that matter. The interest rates on home equity lines of credit are generally adjustable rates, so they will rise with each successive rate hike. That higher rate will be reflected in the next one or two billings due to reset delay times.

Zillow went as far as to address whether home buyers and mortgage seekers should actually buy down their rates. They pointed out that rates are up a full half-point so far in 2017 and that mortgage rates could go higher. Their warning is that mortgage rates will rise as the Fed’s economic tone becomes more optimistic. Zillow’s supposition shows how paying a point can lower your borrowing costs:

If you were getting a 30-year fixed loan of $325,000, you might get two options with and without points. Today the option with zero points might show the rate as 4.25 percent, and the option with 1 percent in points — equal to $3,250 — might show the rate as 4 percent. … Paying $3,250 at closing to lower your rate by .2 percent lowers your payment $42 per month, and lowers your interest cost $68 per month.

Higher interest rates are not unexpected at this point. The question is whether the rise that has been seen in long-term rates already reflects the expected rate hikes. Many market pundits do not feel that the rates on longer-dated Treasuries (and therefore mortgages) will remain this low if President Trump gets his way on lower taxes, regulatory reform and infrastructure and job repatriations.

Stay tuned.